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Executives

Nancy Vincent - Director, Investor Relations

Charles H. Turner - Chief Financial Officer, Executive Vice President

Alex W. Smith - President and Chief Executive Officer

Analysts

TJ McConville - Raymond James and Associates

Joel Hull - Keybanc

Pier 1 Imports, Inc. (PIR) F2Q10 Earnings Call September 17, 2009 11:00 AM ET

Operator

Good morning, ladies and gentlemen. This is the Pier 1 Imports quarterly conference call. I would now like to introduce Ms. Nancy Vincent, Director of Treasury and Investor Relations of Pier 1 Imports. Ms. Vincent, you may begin.

Nancy Vincent

Good morning, everyone and thank you for joining us this morning. Today our Executive Vice President and Chief Financial Officer, Cary Turner, will discuss the financial results of fiscal year 2010’s second quarter which ended August 29, 2009, which were reported earlier today. Following Cary’s update on the financials, our President and Chief Executive Officer, Alex Smith, will provide a more in-depth discussion about our business during the second quarter. This will be followed by a brief question-and-answer period.

The comments being made today should be considered in conjunction with today’s press release, which if you do not have one, is available to you on the investor relations page of our website at www.pier1.com, as are all of our SEC filings.

Before we begin this morning, I need to remind you that certain comments made during this call may contain forward-looking statements within the meaning of section 21-E of the Securities Exchange Act of 1934 and can be identified by the use of words such as may, will, expect, anticipate, believe, and other similar words and phrases. Our actual results and future financial condition may differ materially from those expressed in any such forward-looking statements as a result of many factors that may be outside of our control. Please refer to our SEC filings, including our annual report filed on Form 10-K, for a complete discussion of the major risks and uncertainties that may affect our business. The forward-looking statements made today are as of the date of this call and we do not undertake any obligation to update these forward-looking statements.

Now to provide you with the detailed results of our second quarter, I will turn the call over to Cary.

Charles H. Turner

Thank you, Nancy. Earlier today, we reported a net loss of $16 million, or $0.17 per share for the second quarter, compared to a net loss of $30 million or $0.34 per share for the year-ago period. Year-to-date, net income was $14 million, or $0.15 per share, compared to a net loss of $63 million, or $0.71 a share last year.

Total sales for the second quarter declined to $287 million from $320 million in the year-ago quarter. Comparable store sales for the quarter declined 7.6%, which can be attributed to a reduction in traffic. Without the effects of Canadian currency conversion rates, comparable store sales for the quarter declined 6.9%. Year-to-date, total sales declined to $568 million from $631 million in the year-ago period. Comparable store sales for the first six months declined 7.5%. Without the effects of the Canadian currency conversion rate, the decline in comparable store sales was 6.5% for the first six months.

Merchandise margins for the second quarter were up 270 basis points to 52% of sales compared to 49.3% of sales last year. The increase in merchandise margin is the direct result of reduced markdown activity and strong input margins. Merchandise margins in the second quarter continued to benefit from supply chain efficiencies such as lower fuel, transportation, and labor costs when compared with the same period last year. For the first six months, merchandise margins increased 280 basis points to 53.1% of sales from 50.3% of sales last year. Merchandise margins in the third and fourth quarters will continue to benefit from higher input margins due to favorable negotiations on product and savings in the supply chain.

Store occupancy costs in the quarter were $68 million compared to $72 million last year. For the first six months, store occupancy costs were $135 million, compared to $143 million in the first six months of last year. This improvement can be attributed to the reduced store count as well as negotiated rent reductions, which I will discuss in more detail in a moment.

During the second quarter, SG&A expenses were $91 million, or 32% of sales, compared to $107 million or 33% of sales last year. SG&A expenses during the second quarter consisted primarily of $9 million in marketing, $65 million in payroll, and $17 million in other G&A costs. During the quarter, SG&A expenses included special charges of $3 million resulting primarily from lease termination charges versus $5 million for the same period last year. Excluding these special charges, SG&A expenses for the quarter declined $14 million to $88 million from $102 million for the same period last year. The reduction in expense was primarily achieved in payroll, insurance costs, and other general operating costs.

For the first six months, SG&A expenses were $197 million compared to $216 million for the same period last year. Year-to-date, SG&A expenses included $22 million of marketing, $134 million in payroll, and $41 million in other SG&A costs. Year-to-date, SG&A expenses included $11 million in special charges versus $8 million last year. Excluding special charges, the year-to-date decline in SG&A of $22 million was primarily the result of decreases in payroll, insurance costs, and other store operating costs.

Over the first six months, our marketing expense was flat compared to last year. Our marketing strategy continues to balance driving traffic with brand positioning, with expenditures being more heavily weighted to the third and fourth quarter to coincide with the critical holiday selling season.

Our private label cardholder continues to be an important target of our marketing efforts. Our rewards program continues to attract new cardholders each month and drive repeat purchases from existing cardholders. Our average ticket on the private label card is three times the normal amount. As a result, sales in the U.S. on our preferred credit card continued to increase throughout the summer. For the quarter, sales on the card were 26.1% of U.S. sales, up from 24.4% in the year-ago quarter. We continue to work with our credit partner, Chase, to ensure that our rewards program continues to drive incremental sales and increased brand loyalty while protecting Chase’s credit exposure.

Overall, results from operations for the second quarter improved by $13 million to a loss of $15 million versus a loss of $28 million in the second quarter of last year.

As we told you in our last conference call, we approached the first half of this fiscal year very cautiously in terms of inventory purchases due to the uncertain economic environment and we’ll approach the second half with a little more confidence. At the end of the second quarter, inventory was $336 million compared to $375 million at the end of the same period last year, or 11% lower than last year.

Our in-transit inventory, which peaked during this period, was $55 million at the end of the quarter versus $44 million last year. Inventory per square foot was $40 versus $43 per square foot last year. We expect inventory to continue with seasonal build during the third quarter to a peak of approximately $350 million at the end of the third quarter.

We have been able to maintain a strong liquidity position. As of the end of the quarter, cash and cash equivalents were $109 million. Enhancing our liquidity position is the availability under our secured credit facility. As of the end of the quarter, the facility had a calculated borrowing base of $267 million. After taking into account all reserve amounts and the $114 million in outstanding letters of credit, $123 million remained available for cash borrowings.

Over the first six months, we did not utilize the secured credit facility for any purpose other than the issuance of letters of credit. During the second quarter, we amended our secured line of credit which expires in May of 2012. As part of the amendment, we elected to reduce the total facility size from $325 million down to $300 million. This reduction will not affect our borrowing capacity going forward as our inventory projections support the reduced commitment amount. Taking into account both the cash and cash equivalents and the availability under the line of credit for cash borrowings as of the end of the quarter, our total liquidity was $232 million.

As we previously reported, we continued our commitment to reducing the principal balance of the 6.375% convertible notes in advance of the potential put date in February 2011. During the quarter, we completed two simultaneous transactions. Using $4.75 million of cash, we repurchased and retired $5 million of the outstanding convertible notes. At the same time we entered into separate privately negotiated exchange agreements under which we retired $64 million of the existing 6.3% convertible notes in exchange for $61 million of newly issued 9% convertible notes. The new notes have an initial conversion price of approximately $2.50 per share, or approximately 399 shares of Pier 1 common stock per $1,000 note. The first potential put date for these notes is not until February 2013, a two-year extension from the original notes. Additionally, since the new notes have a much lower conversion price, it has significantly increased the probability that these notes will be converted into equity prior to that date. As a result of these transactions, we recorded a gain of approximately $2 million.

Generally accepted accounting principles require us to reduce the carrying value of the new notes by approximately $12 million to account for the embedded derivative and the beneficial conversion feature. This discount will be accreted to interest expense through the first put date of February 2013 or upon earlier conversion.

This transaction completes the restructuring of our balance sheet which commenced with the sale of our home office building, followed by the purchase in March of roughly half of our convertible notes at $0.34 on the dollar, and the transactions we have just completed.

In total, we have purchased or exchanged $148 million of our $165 million notes for approximately $0.63 on the dollar.

As of the end of the quarter, the long-term debt that remained on the balance sheet includes $16 million of original 6.375 convertible notes, $19 million in industrial revenue bonds, and the discounted amount of $49 million in new, 9% convertible notes for a total of $84 million, compared to $184 million at year-end.

Capital expenditures for the quarter were approximately $900,000 and we still anticipate spending a total of $7 million over the year, primarily on existing stores and technology upgrades. Overall, we still expect to continue our conservative approach to merchandise purchases, expense planning, as well as capital expenditures.

During the second quarter, we closed 12 Pier 1 Import stores and ended with 1,061 Pier 1 Import stores with 980 stores in the U.S. and 81 stores in Canada. In continuing rental reduction efforts, we have now reached in principle rental reduction agreements on approximately 30% of our stores. These agreements will result in total rental savings of approximately $11 million on a cash basis in fiscal 2010. When adjusted using straight line accounting methods, these agreements will reduce our reported rental expense by $6 million for the fiscal year. Cumulatively, these agreements are expected to reduce rental expense by $37 million with over 75% of the cash savings being realized within the next three fiscal years.

Going forward, we will continue to focus our ongoing efforts on achieving additional rental reductions rather than on lease terminations. We still expect to close approximately 50 total locations this year. The 19 stores that have not yet closed are expected to close during January and February. As a result of lease terminations, we anticipate recording related charges of approximately $13 million during this fiscal year, of which $10 million have already been recorded in the first six months. The cash portion of these charges will be partially offset by the liquidation of inventory in the closing stores. We are very appreciative of the willingness of our landlords to work with us as we strive to improve the profitability of our real estate portfolio.

Now I would like to turn the call back over to Alex to give you an update on the business.

Alex W. Smith

Thanks, Cary and good morning, everyone. I want to start by repeating something from the last call -- we said that we have confidence in our merchandise assortments and our in-store experience and that we are well-positioned to benefit from any up-tick in consumer spending.

Our second quarter results have reinforced our confidence level and we are extremely pleased with the progress we have made in quarter two as our sales and operating results again exceeded our expectations. We firmly believe that our single-minded focus on our business priorities which speak to great merchandise, great stores, and a lean and efficient infrastructure, have served us well and will continue to serve us well in the future as we work towards increasing comp-store sales and merchandise margins.

As you know, during the quarter we were able to effectively restructure the balance of our convertible debt. This is a big win for our company. We anticipate that the new convertible notes will become equity in the short to medium term, at which point we will be substantially debt free and we will be able to make additional investments in both stores and infrastructure.

Also this quarter, we were pleased to welcome Cathy David to the Pier 1 Imports family as our chief merchant. Cathy’s appointment completes the transformation of our senior leadership team. We have a wonderful blend of talented and experienced executives who are focused, you will not be surprised to hear, on executing our business model flawlessly.

During the second quarter, we continued to evaluate our inventory levels carefully and further refined our open to buy mechanisms. The net result was that good management of our seasonal inventory and more accurate buying allowed us to shorten our semi-annual clearance sale and got us back to regular trading two weeks earlier than last year. We expect to see a similar shortening of the winter sale which starts immediately after Christmas.

This careful seasonal inventory management combined with all the other improvements to merchandise and supply chain resulted as we expected in significantly better merchandise margins on a year-over-year basis. We expect this trend will continue through the balance of this year.

As Cary reminded you, we bought extremely cautiously for the first two quarters and less cautiously for the fall and holiday season, as we told you we would. We made this decision based on our expectation of a stronger comp store sales trend in the second half of the year. So far, so good. We are now 19 days into the quarter and although it is too early to predict the final outcome at the end of 90 days, we are seeing improvements in traffic and conversion rates resulting in positive comp store sales so far in September.

We are especially pleased that our comp store sales increase is outpacing the increase in traffic.

We are excited by customer response to new and repeat merchandise. Harvest and Halloween is selling well and the initial response to creature comforts, our first fall event, is also really good.

We continue to see improvements in both our furniture and non-furniture business, which is good news because it means that we are no longer under pressure from average ticket declines so with very modest improvements to conversion rates and traffic, we will continue to drive positive comp store sales.

We have a strong bedroom event planned for October and then our holiday assortments will hit the stores after that. I can hardly wait.

Our third and fourth quarters are supported by a strong marketing campaign, which includes direct mail, Internet, newspaper, and social networking. We have also changed our marketing strategy for the day after Thanksgiving and we will be more aggressive than in previous years.

We will spend twice as much in marketing dollars in quarter three compared to quarter two and our spend will be a couple of million dollars above last year. Quarter three is the biggest marketing spend of the year to support the holiday selling season.

Overall, we feel good about our business, what we have achieved and what is to come. We have done so much to make our company leaner and more efficient -- now it’s all about growing the top line. We are confident that if the improvements in customer traffic continues, we will be able with our improved merchandise and in-store experience to generate positive comp store sales at solid merchandise margins.

Lastly, we are hosting a store tour in New York City on October the 13th. The store will be set for the holidays and our executive team will be on hand to answer your questions. If you would like to join us, please let Nancy know and we will get the detailed information to you.

Thank you for joining us today and we’ll now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will go to the line of Budd Bugatch from Raymond James and Associates.

TJ McConville - Raymond James and Associates

TJ McConville filling in for Budd, who is traveling today. Cary, Alex, the one question I had for you is in regard to the merchandise margin. I know in the release you talked about expectations for continued improvements on a year-over-year basis. I’m just trying to get a sense of maybe what we are looking at as far as comparison versus last year. Obviously the fourth quarter with all the necessary discounting, we saw the pressure there but when did we really start to see things taper off? Was it closer to the Lehman collapse or did it really push out into the fourth quarter last year? And give me a better basis for comparison.

Alex W. Smith

From the sales perspective, the sales started to tail off really kind of about now, mid-September, and then it deteriorated September, October, and then into December. The margin held up okay-ish in the third quarter but then of course the inventory was building and so we got to the -- through to the Christmas period and then had to start discounting to get our inventories in line by the end of the fourth quarter. So that fourth quarter you see for last year was extremely low and we certainly expect to beat that very substantially.

TJ McConville - Raymond James and Associates

Gotcha, so maybe more easier to look at on a sequential basis is maybe the traditional 200-ish basis point improvement in 3Q versus 2Q, where we should be looking? Is that about what we would expect? I know you don’t want to quantify exactly but --

Alex W. Smith

No, I don’t want to quantify but I think it’s fair to say that all things being equal, the merchandise margin in quarter three should be a little higher than quarter two in absolute terms and the merchandise margin in quarter four, because it does include the winter sale, will be lower than quarter three. So I think you can go back and look at the pattern over the last few years -- you should see it pretty clearly.

TJ McConville - Raymond James and Associates

Right. Okay, that was it, guys. Thanks for taking my question and excellent job this quarter.

Operator

Your next question will go to the line of Joel [Hull] from Keybanc.

Joel Hull - Keybanc

This is Joel. I’m filling in for Brad who’s on the road right now. Good morning, Alex. Good morning, Cary. Congratulations on the improvement. So just to follow-up on some updated plans for store closures, it’s apparent that you guys have been able to get a significant rent reduction from a lot of stores but can you talk a bit more about how you are thinking of the store base? Is this the appropriate number of stores you want to have over the long-term and maybe what level of stores you might want to close?

Charles H. Turner

I think based on everything we told you now, we expect to end the year with approximately 1,040 stores, with 80 in Canada, and when we take a look at next year, depending on negotiations with landlords and natural lease expirations coming up when the lease is up, we’ll probably close some 20 stores or so. As we continue to look, we’re looking at every single store in every single market and depending on the individual landlords and the good news is we have a lot of individual landlords, we will be taking a look at it market by market. We’d like to say at some point we’ll start to fill in the holes but right -- because there are some markets we have left that we want to get back into but right now we’re not prepared to talk about that.

Joel Hull - Keybanc

Okay. Thanks. Also, could I just get a follow-up on the balance sheet -- could you just give us an update on how you feel about it? Do you feel that there’s any updates on any areas of opportunity to improve it? And in general, how do you feel about it at this point?

Charles H. Turner

I think as we said, we feel very comfortable with it and we feel very good about our liquidity position.

Joel Hull - Keybanc

Okay, okay. I just want to make sure. Thanks.

Alex W. Smith

Okay. Thank you very much. Thanks for joining us, everybody and we will hopefully see some of you in the store and everyone else, we’ll talk to you next time. Thank you.

Operator

This concludes today’s conference. You may now all disconnect.

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Source: Pier 1 Imports F2Q10 (Qtr End 8/29/09) Earnings Call Transcript
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